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The spreading financial crisis has us in the clutches of a tough bear market in stocks. The NIGHTMARE on Wall Street is spilling over to Main Street, and is becoming an even bigger threat to your wealth.
The unprecedented volatility we’re seeing in financial markets is like nothing ever experienced before. Triple-digit swings in the Dow have become common! One day stocks are soaring … the next they’re sinking again!
In the past few weeks alone: Lehman Brothers, AIG, Merrill Lynch, Fannie Mae, Washington Mutual … ALL of these former blue-chip financial stocks have either vanished entirely, or ceased to exist as independent firms due to this crisis.
The White House says: “trust us”, as the government gears-up for an unprecedented taxpayer funded bail-out of Wall Street; but what — if anything — this plan will do for most Americans is anybody’s guess.
In fact, there are more unanswered questions than answered: can the FDIC fully protect you against more bank failures ahead? How safe are money funds? How much lower could home prices fall before housing finally bottoms? What’s the outlook for stocks now?
Five million American homeowners are delinquent on their mortgage loans or in foreclosure already. This fact alone will remain a significant drag on consumer spending, in turn keeping stocks under pressure for some time to come. And once investors realize how much the government is on the hook for— likely to be measured in trillions of dollars — fixed-income investors could rebel too, demanding higher yields on government bonds.
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| Mike Burnick, Director of Research and Client Communications, Sharon A. Daniels, President, Sebastian Leburn, Chief Investment Officer, Weiss Capital Management, Inc. |
This could easily lead to a double-whammy for investors — severe bear market declines in BOTH stocks AND bonds at the same time.
Many of our clients have asked us not only for guidance in these trying times, but also for a strategy that can offer them self-defense in a severe bear market climate. To help answer these pressing questions — and many more — two of my trusted colleagues and I held a special video briefing last week: The Bear Market Defense Forum.
In this briefing we discussed our outlook for the economy and financial markets, plus offered a potential solution to help defend your wealth, and potentially earn profits for you, even in this bear market! Interested? There was too much material to fit into one issue of Money and Markets. So here’s an edited transcript of the first half of the Bear Market Defense Forum …
The Bear Market Defense Forum
(Edited Transcript of Part I)
Sherri Daniels: Welcome to Weiss Capital Management’s Bear Market Defense Forum.
Today, we find ourselves in the midst of the biggest global bear market in stocks since 1970,1 erasing nearly $18 TRILLION dollars in equity market value worldwide.2
Financial markets are caught up in a whirlwind of volatility. Investors are confused. Some are even bordering on panic.
My name is Sharon Daniels, president of Weiss Capital Management, a Registered Investment Advisory firm and an affiliate of Martin Weiss’ Weiss Group of companies. We manage about $350 million in assets and have been managing money for our clients since 1983.
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I’ve been in the financial industry for over two decades and with Weiss since 1990. In all these years I have never witnessed such unprecedented events, as those we are living today.
Much of the financial sector is teetering on the brink. Corporate America and consumers alike are feeling the pressure from the ongoing credit crunch and the worst U.S. housing slump since the Great Depression.3 Globally, banks and brokers have so far reported $500 billion in credit-related losses.4
We have the highest consumer price inflation in 17 years and every sign of the worst recession in 18 years.5 And we also have the greatest federal bailouts in history, including a massive new effort by Congress to save the nation’s weakest banks.
However, these actions do NOT change what’s happening on the ground — 5 million Americans can’t pay their mortgages and are delinquent or in foreclosure, millions of homes continue to fall in value, and America’s huge credit markets are still in danger.6
And — no surprise here — the S&P 500 Index “officially” entered bear market territory in July — falling over 20% from its high last year.
If you’re very concerned and perhaps a bit confused by this climate, you’re not alone. Many of our clients have asked us not only for guidance in these trying times, but also for a strategy that can give them self-defense in bear markets.
That’s why we’re here today: To give you guidance; and to give you a self-defense plan.
In the next half-hour, we’re going to share our outlook with you. We’ll tell you where we see the financial markets and the economy headed over the course of 2008, and into 2009. We will offer you some concrete suggestions on what to do. And we will give you some highlights of our own Weiss Bear Strategy — a program we offer that was first introduced nearly eight years ago, and is specifically DESIGNED to “hedge” your investments — AND BUILD — your wealth in a bear market.
Joining me today is our Director of Research and Client Communications, Mike Burnick, and Sebastian Leburn, our Chief Investment Officer, and portfolio manager of the Weiss Bear Strategy.
Mike, let’s start with you. As our director of research and client communications, your role is to conduct extensive research and you are in charge of communicating our outlook to our clients and prospects. In our most recent Investor’s Quarterly newsletter, we laid out our views on the economy. So let’s get to the heart of the matter: Are we in a recession or not?
Mike Burnick: Waiting for the “official” declaration of recession is perhaps the cruelest joke on investors, but it’s certainly no laughing matter. Sherri, everything we see today tells us the recession began in late 2007. But by the time government officials revise and re-revise their data — by the time they finally SAY we’re in recession — it could be a full YEAR after the fact! But, for investors making decisions TODAY — here and now — that’s way too late.
A perfect example is Japan, 20-years ago, right after its real estate bubble burst. Tokyo share prices peaked in 1989, but Japan didn’t “officially” enter recession until 1993 — four years later.
By then, the Nikkei had already plunged 50% in value.7 As it turns out, that was just the beginning of a long-term SECULAR bear market for Japan.
In fact even today — nearly 20 years later — Japanese stocks are nowhere near their old highs. Share prices have been declining or going sideways for almost two decades, and Japan has had several recessions along the way.
Sherri: So there are lessons to be learned from Japan’s experience that apply to the U.S. today. Economists cite Gross Domestic Product. They’re a bit disappointed our economy is growing only 2% year over year.8 But they seem to find some consolation in the fact that it is still UP, not DOWN. The economy is expanding, not contracting, so if that’s the case, then how do we really know if we’re in recession?
Mike: Well, Gross Domestic Product is fine for economists, but for investors, it’s just too backward looking. Take second quarter GDP, for example. It looks all the way back to a period that began on April Fool’s Day, and ran through the end of June.
If you make your investment decisions based on this kind of backward data, well, your results are going to be a bit like driving your car down a speeding highway looking ONLY in your rearview mirror!
We prefer to rely on REAL TIME information.
Sherri: For example?
Mike: For example, take a look at Initial and Continuing Unemployment Claims which are released every Thursday morning, covering the most recent week.
As you can see, these paint a very ugly picture right now. In fact, unemployment claims are now very near their highest levels in four years.9 Indeed, the unemployment rate rose last month to more than 6%, the highest since 2003. The economy has lost over half a million jobs since the first of this year.
Sherri: And that doesn’t include the recent Wall Street layoffs; such as 25,000 at Lehman.
MIKE: Right, I’m thinking we’ll see a lot more unemployment claims coming out of Wall Street before this is over! Personal income growth is stagnant too! In fact, “real incomes” in the U.S., adjusted for inflation, actually FELL at a 7% rate over the last three months. That’s the worst showing since 1990.10
Or, look at retail sales, which posted an outright decline the past two months straight. It’s pretty clear that consumer spending is faltering because wages just haven’t kept pace with inflation.
Sherri: People I talk to these days are forced to spend more of their meager incomes on “necessities” — like food and gasoline.
Mike: Exactly, it’s a classic CONSUMER SQUEEZE and remember: consumers like you and me and Sebastian; we make up over TWO-THIRDS of the U.S. economy — or that GDP number we talked about — and consumers are really getting squeezed from all sides right now.
Unfortunately, the pressure on consumers is likely to get even worse because home prices are falling, because credit is hard to get, because they’re squeezed by soaring food, energy and healthcare costs, and because more and more people are afraid of losing their jobs.
Sherri: This is what you mean by real time data!
Mike: Yes, certainly a lot closer to real time than GDP. But for TRUE, up-to-the-minute, real time information Sherri, LOOK AT WHAT THE MARKET IS TELLING YOU!
Sherri: The stock market, you mean.
Mike: Yes, the stock market, especially the stocks of our nation’s largest and most prestigious financial companies, which have already lost half, two-thirds, even four-fifths of their peak values. We follow bond market indicators very closely too.
But there’s also another market you should look at closely … it’s a very critical market to watch … but many people don’t even know it exists. I’m talking about the market for CREDIT DEFAULT SWAPS. This is the market where thousands of institutions bet on the probability of FINANCIAL FAILURES.
Sherri: You’ve hit the nail on the head with that, Mike. At Weiss, we’ve been carefully monitoring exposures to these “structured investment vehicles” for many months. So, for the benefit of our audience, can you explain exactly what these credit default swaps are?
Mike: Sure, Credit Default Swaps (CDS) are essentially insurance contracts that big investors buy to protect themselves from the possibility that some of the people they do business with could go broke. Let’s say you’re Merrill Lynch. And let’s say I’m JP Morgan. You do billions of dollars of business with me. But you’re afraid I might default and leave you hanging with huge losses.
Sherri: Right. Unless I could cover that risk somehow, there’s no way I would continue doing business with you.
Mike: Exactly, so you pay a premium to buy protection; that’s a credit default swap. It’s essentially a life insurance policy on the health of the firm, like JP Morgan. If it fails, you get a big pay-off. If not, the seller of this insurance earns a nice premium.
Sherri: So let’s talk about how we use this to keep track of the economy in real time.
Mike: The value of CDS contracts are quoted just like stocks and bonds, although individual investors don’t trade in this market, it gives us REAL TIME tracking of the CREDIT CRUNCH. When the credit crunch gets worse, it means banks are tightening lending standards.
Sherri: It means businesses and consumers all across the country have less access to the credit they need …
Mike: Right, credit is the life-blood of the economy; without it consumers are going to buy less, drive less, and spend less. BUT, on the other hand, if the credit crunch is easing, it means there’s LESS downward pressure on the economy. We can follow all this — in real time — reflected in the market value of CDSs.
Sherri: The Fed and the Treasury are pumping billions into the financial system to ease the credit crunch, but are these efforts working? What’s your take?
Mike: Well, what we see in the market for CDS shows it’s NOT working. Look! Here’s the average of all the two-year credit swap premiums, courtesy of Bloomberg.
When this real time indicator is going DOWN, it’s a sign that the credit crunch is easing. When it’s going UP, it’s a sign that the credit crunch is worsening. And remember: This is the key force that we believe could make or break the economy in the months ahead.
Sherri: I see a few lines in this chart and they are obviously all trending higher — not lower. Which one, in particular, should we be watching?
Mike: For the Big Picture trend, the one to watch is the yellow line, the 200-day moving average. It started going up over TWO YEARS AGO, in the middle of 2006. And it HAS NOT STOPPED GOING UP EVER SINCE! NOT ONCE!
This means that, despite all the talk about government rescues and government stimulus, despite temporary respites here and there, the credit crunch has continued to get progressively WORSE.
Sherri: 200 days? Isn’t that ALSO like looking in the rear-view mirror?
Mike: Yes, it is. And that’s why I watch the WHITE line here even more closely — this is what’s happening right now, today, in REAL TIME. In recent days, as you can see, the white line surged to a new high this year. At Weiss Capital Management, this tells us the credit crunch is still strangling our economy.
In the wake of the Fannie & Freddie fiasco, Lehman’s BANKRUPTCY, and then Merrill Lynch, the crisis is clearly getting WORSE NOT better. CDS contracts on the nation’s biggest banks are going through the roof — Wachovia, Washington Mutual, Citigroup; you name it. This tells us that more FAILURES ahead are a growing probability. That’s a big reason why I think the recession has barely begun Sherri, and it’s a big reason why I believe stocks may stay under pressure.
Sherri: At Weiss Capital Management, we hold our Investment Committee Meeting every Monday morning, and one of the points you frequently stress Mike, is how important it is to NOT be swayed by prevailing market sentiment. Could you explain?
Mike: Here’s the key: You DON’T WANT TO GET CAUGHT FOLLOWING THE CROWD. Most investors know that intellectually. They know they should think independently. But what they know based on reason and what they DO, based on EMOTION are, unfortunately, two entirely different things.
Sherri: It’s difficult to remain disciplined with markets this volatile …
Mike: True. When nearly everyone with a big name, everyone you trust, is saying “all is fine and dandy,” Or when everyone is saying “the Fed will save us,” or “Congress will bail everyone out with this new Resolution Trust structure,” it’s hard to buck that sentiment. But you must.
You know, it’s hard to say how this bailout plan from the government will ultimately impact our financial markets. Beware the law of “unintended consequences.” What does look clear is that it’s going to cost taxpayers a bundle — perhaps a TRILLION dollars or more to clean up this mess, and the fallout from this could impact stocks, bonds, and the economy in new and unknown ways.
We’ve seen this all before, in case after case, when the government announced a rescue plan and the so-called “smart-money” crowd on Wall Street said the “coast is clear,” but it really wasn’t.
Sherri: I remember several situations like that. Several years ago, during the dot.com bubble for example. And more recently last fall, many were saying the credit crunch would only impact a narrow segment of our banking sector; that it would not spill over into the real economy. But the exact opposite happened.
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Mike: Right. Of course the crisis has gotten much worse since then, and the big Wall Street banks and brokers are knee-deep in this mess. In fact, they have posted the biggest losses by far. Bear Stearns insolvent in March, then Lehman — which survived on Wall Street for 158 years — went BANKRUPT in September. Even Merrill Lynch could NOT survive as an independent firm.
The casualty list is growing fast on Wall Street, so I’m wary when I hear any of these big firms say: “Don’t worry — all’s well.” That’s when I hold on to my wallet with both hands!
Sherri: When this crisis started last year we were early and vocal in pointing out the danger.
Mike: We began warning our clients as early as April of last year —2007 — months before the credit crunch began shaking the foundations of Wall Street.
In our Investor’s Quarterly newsletter back then we wrote that a FUNDAMENTAL SHIFT was under way — in the economy and the stock market.
We believed then that the rapid deterioration in housing, the surge in sub-prime loan losses, would spill over into the broad economy. That’s why we warned our clients back then of a sharper than expected slowdown.11
Sherri: Some well-respected experts were dead wrong about the severity of this credit-crunch to begin with, weren’t they?
Mike: Absolutely. That’s a prime example of NOT following the crowd. That’s why it pays to be cautious when sentiment appears too complacent — you’ve got to think for yourself.
Right now, the “crowd” is focused on whether or not this is a recession, but that’s beside the point. Regardless of Federal bailouts, we’re already in a bear-market environment here. The worst of the financial sector crisis may be over — IF this bailout proves effective — and that’s a BIG if. But this has ALREADY spilled over from Wall Street to Main Street. Five Million American homeowners are now delinquent on their mortgages or in foreclosure already.12 So we haven’t even seen the full impact on the economy yet, which will only get worse from here.
Editor’s note: This ends the first half of the program. To view the entire Bear Market Defense Forum, turn up your computer speakers and click here. In the second half of the presentation, we discuss the Weiss Bear Strategy, a professionally managed investment program that’s designed to hedge against market declines, and potentially earn profits, even in a bear market climate. This information and more is included in the program. And please look for Part II of the Bear Market Defense Forum transcript in a special edition of Money and Markets next week.
Sources:
1 The Economic Times: “Wall Street way off target in emerging market forecasts”, 7/15/08
2 Bloomberg: “European Stocks Rise as Inflation Concern Eases; RBS, EADS Gain” 8/15/08
3 The Economic Times: “Wall Street way off target in emerging market forecasts”, 7/15/08
4 Bloomberg: “European Stocks Fall on Writedown Concerns; HSBC, Airlines Drop”, 8/21/08
5 Bloomberg: “US Consumer Prices Rose more Than Forecast in July”, 8/14/08
6 U.S. Treasury Department: “Statement by Secretary Henry M. Paulson, Jr. on Comprehensive Approach to Market Developments,” 9/19/08
7 Merrill Lynch Economic Analysis: “The Elusive Bottom” 8/14/08
8 Decision Economics, Global Economic Developments, 9/5/08
9 Ned Davis Research: Daily Economic Commentary, 7/24/08
10 Merrill Lynch: The Market Economist, 08/01/08
11 WCM Investor’s Quarterly 2nd Quarter, April 2007
12 U.S. Department of the Treasury, “Statement by Secretary Henry M. Paulson, Jr. on Comprehensive Approach to Market Developments”, 9/19/08
Important Disclosures:
Weiss Bear Strategy Complete Performance History:
PERFORMANCE: of the Weiss Bear Strategy depends on the performance of the underlying mutual funds in which it invests. In turn, performance of the underlying mutual funds depends on the performance of equity and fixed-income markets. Returns are based on a composite of actual client accounts. Individual client returns may vary depending on, among other things, account opening date, contributions, withdrawals, and fees. Actual fees may vary depending on, among other things, the applicable fee schedule and portfolio size.
Net returns cited include actual management fees, commissions, and other similar fees charged on transactions, and reinvestment of dividends, income and capital gains. Gross returns cited exclude management fees and are net of actual commissions and other similar fees charged on transactions, and include dividends, income and capital gains.
BENCHMARK: The S&P 500 Index is a capitalization-weighted index that consists of 500 large-cap US stocks, which assumes the reinvestment of dividends and capital gains, and excludes management fees, transactions costs and expenses. It is not possible to invest in an index. Index return data source: Bloomberg.
Please Note: The preceding article may contain forward-looking statements regarding intent and belief with regards to the Weiss Bear Strategy and the market in general. Readers are cautioned that actual results may differ materially from those statements. Past performance is not indicative of future returns and, as with any investment program; it is possible to lose money by investing in the Strategy. There are no guarantees that the program will be able to achieve its stated objectives. Before investing, please read the Firm’s ADV Part II and all program materials.
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Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Tony Sagami, Nilus Mattive, Sean Brodrick, Larry Edelson, Michael Larson and Jack Crooks. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual prices investors pay or receive. Regular contributors and staff include Kristen Adams, Andrea Baumwald, John Burke, Amber Dakar, Dinesh Kalera, Christina Kern, Red Morgan, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau and Leslie Underwood.
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